C11 Valuation methods

Question 1

What is economic value?

Answer 1

Measure of the benefit provided by a good or service to an economic agent
max. amount of money a specific actor is willing and able to pay for the good ≠ market price (exchange value)

Question 2

5 different valuation methodologies

Answer 2

(1) Public Market Comparable Analysis: Relative to Peers
(2) Acquisition Market Comparable Analysis: relative to precedent transactions
(3) Discounted Cash Flow Analysis: fundamental/intrinsic value
(4) Merger Consequences Analysis: affordability analysis
(5) Leveraged Buyout Analysis: who is the financial sponsor or private equity firm which can pay for the amount being asked?

Question 3

Purposes for conducting a valuation

Answer 3

(1) IPOs and SEOs: Public Market Comparables
(2) Debt offerings: credit, high yield and bank debt comparables
(3) M&A:
- buy&sell side advice
- divestures, restructuring, recapitalizations & LBOs(leveraged buy-outs)
- defense analysis: is the underlying company vulnerable to a hostile takeover
- fairness opinions: is the price „fair” from a legal standpoint
(4) Research - Equity Analysts

Question 4

Three types of CFs

Answer 4

(1) Free Cash Flow (FCF) -> Enterprise Value
(2) Capital Cash Flow -> Enterprise Value
(3) Equity Cash Flow (ECF) -> Equity Value

Question 5

formula FCF (=unlevered CF)

Answer 5

FCFt = (1-t) x EBITt + Depreciationt - CAPXt - △NWCt
FCFt = NetIncomet + (1-t) x Intt + Dept - CAPXt - △NWCt
with CAPXt ≈ PPEt - PPEt-1 + Depreciation
with △NWCt = △Inventory + △AccPayable - △AccReceivable

Question 6

formula FCF if depreciation tax shield is given

Answer 6

depreciation tax shield = t x Depreciation
FCF = (Revenues - Costs) x (1-t) - CAPX - △NWC + t x Depreciation

Question 7

Which discount rate r to use for FCFs?

Answer 7

(1) when all-equity financed: r = rE (exp. return on equity = cost equity)
(2) when all-debt financed: r = rD(1-t) (rD=exp. return on debt holders = cost of capital for debt)
(3) when partly equity- and debt-financed: r = after-tax WACC

Question 8

formula after-tax WACC

Answer 8

WACC = (E/V) x rE + (D/V) x rD x (1-t)
with E,D,V: market values (!)
with D: net debt = debt - cash

Question 9

Capital Cash Flow (CCF)

Answer 9

CCFt = FCFt + t x Interest Expenset
CCFt = EBITt - t x EBTt + Dept - CAPXt - △NWCt
CCFt = NetIncomet + Interestt + Dept - CAPXt - △NWCt

Question 10

Equity Cash Flow (ECF)

Answer 10

ECFt = Capital Cash Flowt - Debt Cash Flowt
ECF = NI + Dep - CAPX - △NWC - [Debt Payments - Debt Issues]
disount rate: rE

Question 11

Estimating cost of capital for publicly traded firms

Answer 11

via CAPM:
E[R] = rf + ß x ( E[RMkt] - rf )

Question 12

Estimating ßA for private firms and projects with different asset risk (without taxes)

Answer 12

(1) Find identical or „twin” company(ies)
(2) Find their ßE
(3) Get their ßA by unlevering ßE: ßA = (D/V)ßD + (E/V)ßE
(4) Take an average of the ßA’s

Question 13

Relever ßA (without taxes)

Answer 13

Using the project’s target capital structure:
ßE = ßA + (D/E) x (ßA-ßD)

Question 14

Relationship D/V and D/E

Answer 14

D/V = (D/E) / (1+D/E)
D/E = (D/V) / (1-D/V)